Cash Conversion Cycle and Profitability of a

Firm in Food Sector of Pakistan

A THESIS SUBMITTED TO
THE PUNJAB COLLEGE OF COMMERECE
(UNIVERSITY OF CENTRAL PUNJAB)
IN FULFILLMENT OF THE REQUIREMENT
FOR THE DEGREE
MASTERS IN COMMERCE (ACCOUNTING & FINANCE)
BY

Muhammad Tayyab
Supervisor: Faisal Baloch

PUNJAB COLLEGE OF COMMERECE

University of Central Punjab
2014
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RESEARCH COMPLETION CERTIFICATE

Certified that the research work contained in this thesis Cash Conversion Cycle and
Profitability of a Firm in Food Sector of Pakistan has been carried out and completed by
Muhammad Tayyab Reg # S4F12MCOM0054 under my supervision during his masters of
commerce.

_______________
Principal

Date:__________________

Punjab College of Commerce

University of Central Punjab

Research Supervisor:______________________

Lahore, Pakistan

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Certificate of Examination
Certified that quantum and quality of the research work contained in the thesis Cash
Conversion Cycle and Profitability of a Firm in Food Sector of Pakistan adequate for the
award of degree of Masters of Commerce.

Internal Examiner

External Examiner

Signature: ______________

Signature: ______________

Name: _________________

Name: _________________

Date: __________________

Date: __________________

Principal:
Signature: ______________
Name: _________________
Date: __________________

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Declaration:
I, Muhammad Tayyab Reg No S4F12MCOM0054, Student of masters of commerce during the
session of 2012-2014, hereby declare that the matter printed in the dissertation titled Cash
Conversion Cycle and Profitability of a Firm in Food Sector of Pakistan is my own work
and has not been printed, published and submitted as research work in any form in any
university, research institute etc in Pakistan or Abroad.

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Dedication:

I would like to dedicate this report to my dear parents and respected teachers who guided me
through my studying carrier and still doing their best for me. To be here in this institution at this
level I am just because of my parents, especially their training, guidance, love, affection and
motivation. I pray that I can serve my parents as best as I can.

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ACKNOWLEGEMENT

First of all I am very thankful to Almighty ALLAH who gave me courage and confidence to
making this dissertation. I am also thankful to respected Sir Faisal Baloch & Sir Waqar Ahmed
in the UCP campus sargodha, who gave me chance and opportunity to make such a professional
project, in which I analyze the entire scenario regarding food industry. They have been a steady
source of track throughout the course of this whole internship. Their innumerable ideas were
precious and gave me with an insight to the path, which was off the beaten track otherwise. I have
yet to see the limits of their sympathetic, stamina and altruistic concerns for me. I am especially
thankful to my parents and friends for giving me the silent support in terms of courage and strength
that I needed to accomplish my goals. Words might not be adequate to express my feelings towards
them.

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Abstract:
CCC is very important for every manufacturing firm because it helps the manager to maintain
inventory keeping time properly. CCC tells us how a manufacturing firm is able to manage its
inventory properly. There must be a balance between assets and liabilities in order to maintain
working capital properly. The data which is used in this article is obtained from financial
statements of companies registered in Karachi stock for the year 2006 to 2011. The sample
consists of 54 firms in food sector. Regression analysis is used to examine the relationship of
CCC with profitability of firms in food sector of Pakistan. In regression analysis we used Return
on Assets and Gross profit to total asset as dependent variable. The study evaluated that there is
Positive relationship between CCC and profitability of food sector of Pakistan from 2006 to 2011

KEY WORDS:
Cash conversion cycle, profitability, food sector, Karachi stock exchange, CCC

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Contents:
Chapter#1:

Page#

1.1.

Introduction.11

1.2.

Food Industry of Pakistan.12-16

1.3.

Cash conversion cycle....17-19

1.4.

Purpose of study...20

1.5.

Period of study..20

1.6.

Problem Statement...21

1.7.

Objectives..........................................................................................................................21

1.8.

Research Question21

1.9.

Research model22

1.10. Research hypothesis.23

1.11. Importance24
Chapter#2:
2.1.

LITERATURE REVIEW...24-29

Chapter#3:
Research Design and Methodology
3.1. Population..30
3.2. Research Approach/Design..30
3.3. Data Collection..30
3.4. Analysis..30
3.5. Regression analysis...30
3.6. Cash Conversion Cycle Operationalization31
3.7. Profitability Operationalization.32-33
Chapter#4:
Analysis
4.1. Regression Equation: 1 & Results..34-36
4.2. Regression Equation: 2 & Results...36-37

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Chapter#5:
Recommendations and Conclusion
5.1. Recommendation38
5.2. Conclusion39
References..40-43

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Table of contents:
Table #

Title

Page #

1
2
3
4
5
6

Production pattern of sugarcane in the world

Pakistan Sugarcane Area and Yield
Province wise sugar production
Food processing units in Pakistan
Regression equation 1st results
Regression equation 2nd results

12
13
14
16
35
37

Figures
Figure #
1
2
3
4

Title
Urban population trend in food sector across Asian countries
Cash flow cycle
Cash conversion cycle
Research model

Page #
15
17
20
22

List of Abbreviations:
Sr#
1
2
3
4
5
6
7
8
9

Acronyms
CCC
GPtoTA
CR
WCM
ROA
ROE
NPM
TATR
WCtoTA

Abbreviation
Cash conversion cycle
Gross profit to total assets
Current ratio
Working capital management
Return on assets
Return on equity
Net profit margin
Total assets turnover ratio
Working capital to total assets

Chapter#1:
1.1.

Introduction

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The size of global processed food industry is estimated to be valued around US $3.5 trillion and
accounts for threefourth of the global food sales following countries are subject of growth in
food sector in developing countries in Asia, Europe, and AsiaPacific, which are suffering of
high population
There is still potential in ASEAN countries that can be covered with respect to food sector,
having population more than 550 million people. Despite its large size, only 6% of processed
foods are traded across borders compared to 16% of major bulk agricultural commodities

From past five years there is a growth in food sector about 15.9 % annually.

The main food processing industries in the world are America and Europe.

Convenience products such as dried instant soups, reconstituted fruits and juices, shelf
cooking meals are becoming popular throughout the world

Employment ratio in this sector in different major countries is as follows.

US: 12 million

Europe: 2.5 million

After India and china the largest food market in Asian countries is Japan. The most
technologically strong food industry is in Australia; the reason is that the cost of production in
this country is very low.
There are four steps in food industry that are; production, process, transportation and
distribution. We can see that this chain involves all the stakeholders of this sector from small
farmer to a retail distributor. There should be alignment in all of these steps so that it will
produce significant effects and can work effectively around the whole cycle. In order to maintain
competitive edge we should focus on food beverages and Tobacco other then the agricultural
inputs like wheat, maize, cotton and sugarcane, fruits, vegetables and dairy these also play a
significant role in food sector of Pakistan.

Production pattern of sugarcane in the world

Country

Cane Yield (T/ha)

Sugar Recovery (%)

Sugar Yield (t/ha)

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Australia

100.4

13.8

13.85

Egypt

110.8

11.5

12.74

Brazil

68.4

14.5

9.91

USA

80.2

11.7

9.38

Colombia

80.5

11.5

9.26

Mexico

79.5

11.6

9.22

India

66.9

9.9

6.64

Pakistan

49.0

9.2

3.54

World Avg.

64.4

10.6

6.82

Table#1

1.2.

Food Industry of Pakistan

The total production ratio of food sector in Pakistan is 27% and the total employment ratio is
16% which belongs to manufacturing sector. Pakistan having huge consumer base and Pakistan
is at eighth number in the world that covers approximately 169 million consumers, having more
than 1000 large scale food processing units. As effect of globalization food style of consumers is
totally changed in Pakistan. The average individual consumer spending is about 42% of his
income on food items.
There are many fast food chains in Pakistan that are changing the life style of individuals .The
efficiency of food industries depends upon availability of the raw materials and Pakistan is a
bigger producer of many crops (such as wheat, rice, sugarcane and oilseeds)
There are many problems in the food industry of Pakistan. But still there is increasing trend In
our food industry due to the changing demands of the customers as result of globalization. Some
of the major problems include:
* Political instability
* Monopolistic trend
* Lack of resources
* lack of skilled workers
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* rough infrastructural facilities

* ineffective utilization of factors of production
* Transportation issues
* High cost of production.
Pakistan is at fifth number in the world with respect to farming of sugar cane, in production
Pakistan is at eleventh number and in yield of sugar Pakistan is at 60 Th number in the world.
Sugarcane is major raw material for this industry production. After the Indo-Pak separation there is
an increase in the total cultivated area of sugar cane. The sugarcane is cultivated over the area
covering more than 1 million hectares.
In Pakistan there are more than 81 firms which are engaged in production of sugar and their annual
production is more than 6.1 million tons. This sector contribute large amount in GDP of the country
by exporting sugar to other countries and earn foreign reserves.

Pakistan Sugarcane Area and Yield

Year

Area (000 Ha)

Produced 000
Tones

Yield
Hectare

per Utilization %
by Sugar
Mills

2000-01

960.0

43,620

45.4

67.47

2001-02

999.7

48,041

48.1

76.33

2002-03

1,099.7

52,049

47.3

80.28

2003-04

1,074.8

53,800

50.1

81.15

2004-05

966.4

43,533

45.0

73.74

Table#2
Mostly sugar is produced in province of Punjab and Sindh. Very small amount is produced in
NWFP in past Punjab was partly dependent on supply of sugar from Sindh. But now Punjab is
self sufficient in production of sugar due to development in sugar industry in Punjab .Sugar
production is seasonal activity. The mills works approximately 150 day s throughout the year
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Province wise sugar production

(In Tones)

Province
Punjab

2005-06

2004-05

2003-04

2002-03

2001-02

1,832,228

2,182,330

2,599,490

2,351,102

2,152,175

Sindh

1,038,122

801,063

1,221,268

1,158,674

940,959

NWFP

128,157

132,407

176,252

166,983

104,611

Total

2,998,507

3,115,801

3,997,010

3,676,759

3,197,745

Table# 3
A variety of imported food (given below) can be easily seen on shelves of modern retail stores.
The products are as follows soft drinks and fruit juices, Jams and jellies, dry milk, cheese, Ice
creams, almonds, pistachios, Biscuits and wafers, vegetables, medicines, Chocolates ,cereals,
Honey, Tea and coffee, noodles and Baby items.

Growth trend in urban population is as follows in figure #1.

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Figure # 1

The soft drink industry in Pakistan has become major sector in the economy of Pakistan from
several years. As per the latest survey by AAJ TV, almost 170 firms are working in the Pakistan
in this industry. The beverage industry covering Juices, drinks, drinking water, milk, energy
drinks tea and coffee as well. In Pakistan different firms are leading in different products in
beverages based upon their specialization and product
Recently a survey is conducted in 2013 was conducted in October 2013 by Dynamic Research
Consultants The survey results based upon a comparative study between two types of gender
first one is young adult age from 16 to 22 years and second one is matured having age more than
22 years results survey are given below.
The survey findings explain the different consumption patter between the genders having
different age limit. Overall, the results of survey concluded that the females are more probable
to consume different drinks then males. Tea is the more preferred drinks in the mature adults
(having age more than 22 years). While the energy drinks are more consumed by young adults
then the mature adults Drinks that are consider as healthy drinks like mil and fruit juices are
consumed greater in mature the soft drinks are consumed in a huge amount among both of
genders
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Now the tea has become a part of Pakistani culture, Pakistan is at first number in tea
consumption in the world. In Pakistan per capita tea consumption is 1 kg and average tea
consumption in the world is in the world 0.75 kg .

Table#2
In soft drink classification, there are two major competitors all over the world which are PepsiCo
and Coca Cola, and locally in Pakistan gourmet cola is emerging and giving tough competition to
Pepsi and just because of their low cost then both brands.
There is also significant growth in juice industry in Pakistan just because of healthy vitamins
qualities in juices. The solid growth in particular industry is just because multiple

fruits are

cultivated in Pakistan. The government of Pakistan has removed custom duty on export of
locally manufactured juice. There are 38 units which are engaged in production of juices and the
vital firms in this industry are nestle Pakistan Limited, Benz industries and Mitchell
Energy drinks are scored as less consumed beverage then others as the least consumed beverage.
The significant company in this industry is

Red Bull, which is a multinational brand with

aggressive strategies covering 63% share in 2012 .recently Sting was introduced by PepsiCo in
Pakistan and becoming major cold drink and consumed at huge number in adults.
The beverage industry in Pakistan has many opportunities and gaps which are too be filled.
Beverage industry is one of the fewest industries in Pakistan which shows significantly growth
from past years and probably to grow faster in future due to increasing consumption pattern

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among both of genders. According to recently report Pakistan beverage industry in facing two
major threats which are, politically instability and increasing inflation rate in the country .

1.3.

Cash conversion cycle

Liquidity management is one of the most important financial management techniques. It

measures the time in which the inventory is converted into cash again and the account
receivables are recovered.

Figure#2
In accordance with (Siddiquee and Khan, 2009)

effective capital management policies may

become firms competitive edge. And the firm will not need to get loan from outside sources

According to Gardner et al. 1986 there is much importance of Working capital management in
firms operations because it has a direct relationship with the financial performance of a firm.

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Companies can increase their profitability by Decreasing the period of cash conversion cycle by
decreasing the accounts receivables collection time period, and increasing the time period of cash
payments or credit payments. The basic objective of every company is to increase the
profitability of the company so the company focuses on all the factors which affect the
profitability of firm.
Filbeck and Krueger (2005) focus on the performance of working capital management and find
that there are variations in working capital tools from time to time .WCM theory presented by
Richards and Laughlin (1980) explain that cash conversion cycle is a great measure to check the
efficiency of organizational working capital management. It is a great measure to know that how
fine a corporation is organizing its working capital (Nobanee et al. 2011). According to Gitman
(1974) cash conversion cycle is a good evidence of working capital management efficiency, Cash
conversion cycle guide managers regarding investment and credit decisions, inventory and
suppliers management.
Padachi, 2006 tells us that Cash conversion cycle and collection cycle are good indicators for
analyzing firms performance. According to Weinraub and Visscher aggressive working capital
management policies has higher number of risk and also higher volume of payoff and
conservative working capital management policies has lower risk, and lower risk lead towards
lower returns.
According to Jose et al. (1996) aggressive working capital management will tends towards
shorter cash conversion cycle which will leads towards higher profitability of a firm.
In the opinion of Shin and Soenen (1998) in order to get higher returns we have to invest fewer
amounts in current assets, the purpose is to reap the higher risk which will lead towards higher
profits.
Smith (1980) suggested that in order to lower the risk the firm will have to invest in their current
assets heavily but due to lower risk the returns will fall down. According to the old concept of
firms profitability and cash conversions there is inverse relationship between both of them. But
there is a disadvantage that this may harm the working of an organization and also impact the
profitability.
(AlHajja, 2009) suggested that the firm can increase their profitability by reducing the
conversion cycle and cash conversion cycle is reduced by increasing the payment period to
creditors and increasing the time of payment to debtors and inventory days period cycle, the
18 | P a g e

receivable collection period and the inventory conversion period. (Malitz and Ravid, 1993) open
credit terms increases the sale volume of the firm but it effects the short term financial operations
of a firm but narrow credit terms will reduce the sale volume of firm which lead towards lower
profitability.
In contradiction with other studies (Lyroudi and Lazaridis) argue the relationship between
profitability and CCC of a firm and concluded that there is a direct relationship between
profitability of a firm and cash conversion cycle.
There are many reasons of this harmful impact one of them is that when reducing inventory
conversion period there may be a problem of reduction in the collection period, another reason is
that firm may loses its good customers due to demanding of early payment of their debts. And
when the firm increases its firms payable period the reputation of the firm may be on stake,
there should be a proper management between receivables and payables.
Capitalism works through a complex and sometimes confusing process. The basic principle
however is fairly simple. It is basically and free enterprise system that rewards hard work.
We have to identify a proper match between amount receivables and payables. In order to work
more smartly the firms have to boost up their cash receivings and slower their cash payments.
The principal behind this tactic there is the technique of operating cycle and cash conversion
cycle.
We can reduce the cash conversion cycle by minimizing the working capital flow. It can be done
through reducing the time of receivables of debtors and increasing the time of payables of
creditors.

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Figure#3
Cash conversion cycle is considered as important tool to measure working capital and
profitability of a firm. In accordance with (Lyroudi & Lazaridis, 2000) cash conversion cycle
directly affects the liquidity position of a firm. Richards & Laughlin (1980) gives the thought of
cash conversion cycle in important for calculating the effectiveness of liquidity management of a
firm. It represents the gap between cash collections and cash payments .the equation for CCC is
given below:
Cash conversion cycle = operating cycle average payment period
And
Operating cycle = inventory days period + average collection period

1.4.

Purpose of study

The basic objective of our study is to examine the relationship between the cash conversion cycle
and profitability of a firm

1.5.

Period of study

We analyze the financial statements of companies listed under Karachi stock exchange from the
period of 2006 to 2011

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1.6.

Problem Statement

Cash conversion cycle is one of the most important techniques in working capital management
and which affects the firms all financial operations. It directly affects the profitability of firm.
The manager must consider cash conversion cycle while managing cash issues; how the firm will
collect money from debtors and pay this cash to creditors. There are many researches on cash
conversion cycle and financial performance of a firm but there is very little work on cash
conversion cycle and profitability in food sector of Pakistan, this was our research problem to
overcome this gap.
To identify the impact of cash conversion cycle on a firms profitability

1.7.

Objectives

Following are our research objectives.

To determine the impact of cash conversion cycle on profitability.

To determine the impact of average payment period on return on asset and Gross Profit to
total assets

To determine the impact of length of average collection period on return on asset and
Gross Profit to total assets

To determine the impact of inventory days period on return on asset and Gross Profit To
total Assets

1.8.

Research Question:

What is the nature of the relationship among Cash Conversion Cycle and Profitability of food
sector of Pakistan?

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1.9.

Research Model:
Cash conversion
cycle

Profitabi
lity
Return on
assets

Account
receivable
period

Return on
equity

Inventory
days period

Accounts
payable
period

Gross profit
to total
assets

Figure#4

INDEPENDENT VARIABLE

Cash conversion cycle

DEPENDENT VARIABLE

Profitability

Cash conversion cycle includes

Account receivable period

Inventory days period

Accounts payable period

Profitability includes

Return on assets

Return on equity
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Net profit margin

Gross profit to total assets

Control variables:
Total asset turnover ratio
Natural log of sales
Cash ratio
Dividend coverage ratio
Working capital to total assets

1.10. Research hypothesis:

H1: There is a strong negative relation between profitability and cash conversion cycle

Cash conversion
cycle

H1 (Negative
relationship)

Profitability

Ho: There is a strong positive relationship between profitability and cash conversion cycle
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Ho (Positive relationship)
Cash conversion
cycle

1.11.

Profitability

Importance

Our study will contribute to the previous researches in the following ways. Firstly the good
management of working capital is very valuable for shareholders of a firm. Secondly, the
shareholders are more aware about all the operations of a firm related to working capital
management due to digitalization.
This research will contribute significantly towards the food sector of Pakistan and will provide
base paper to future researchers in food sector.

Chapter#2
2.1. LITERATURE REVIEW
(SALEEM, 2012) conducted a research on cash conversion cycle and profitability of 32
companies from manufacturing sector of Pakistan , and they used regression and correlation
analysis to find out the relationship between cash conversion cycle and profitability of firms and
she conclude that there is a negative relationship between cash conversion cycle and profitability
of firms
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(Bhutto, 2011) conducted a research on Relationship of Cash Conversion Cycle with Firm Size,
Working Capital Approaches and Firms Profitability and they selected 157 companies from oil
and gas sector of Pakistan registered at Karachi stock exchange to examine the relationship
between cash conversion cycle and performance of a firm and they conclude that there is a strong
negative relationship between cash conversion cycle and firms sales revenues, return on equity
and return on assets
(A) conducted a research on profitiability and working capital management of firms of Siri
lanka and he chosed manufacturing sector , beverages sector of Siri lanka and he used pearsons
correlation analysis he finds that shoter the cash conversion cycle greater will be the profitability
of firm.
(Nasr, 2007) work on Working Capital Management And Profitability they choose a sample
94 firms registered at Karachi stock exchange for the period of six years and uses Pearsons
correlation and regression analysis in their model and suggested that there is a strong negative
relationship between CCC and performance of a firm .

(Zawaira, 2014) works on the association between working capital management and
profitability of non-financial companies listed on the Zimbabwe stock exchange find out the
relationship between working capital management variables and profitability of firms of
Zimbabwe and they selected a sample of 32 non financial firm registered at Zimbabwe stock
exchange , they used regression analysis in their model and finds that there is a inverse
relationship between payable period and profitability.
(Afza, 2008) concluded about is it better to be aggressive or conservative in
Managing working capital? they selected a sample of 208 public limited companies listed at
Karachi stock exchange for the duration of 1998 to 2005 to find out the impact of aggressive as
well as conservative working capital management policies on profitability of firms and finds out
that there is a strong inverse relationship between working capital policy and performance of
firm.
(Bieniasz, 2011) conducted a research on The Influence of Working Capital Management on the
Food Industry Enterprises Profitability they selected a sample from food sector of Poland to
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analyze the CCC and turnover cycle with the help of debtor, current liabilities, creditor, sales and
finds out that the firms having shorter working capital cycle as compare to larger one have higher
profitability ratio.
(Attari, 2012) works on The Optimal Relationship of Cash Conversion Cycle with Firm Size
and Profitability he choose manufacturing sector of Pakistan and selected 31 firms and collected
the data for the period of 2006 to 2010 and used one way ANOVA and Pearson correlation
method and find that there is a opposite relationship between CCC and profitability
(Mehmet, 2009) have worked on Relationship between Efficiency Level of Working Capital
Management and Return on Total Assets in ISE they collected the data from Istanbul Stock
Exchange and concluded that there is inverse relationship between CCC and profitability (return
on total assets) of any firm.
(Sabri, 2012) conducted a research on Different Working Capital Polices and the Profitability of
a Firm they collected the data of 45 industries from Amman Stock Exchange (ASE). From the
period from 2000 to 2007.they analyzed the data with the help of T-Tests and Mann-Whitney-U
Tests. They concluded that companies are different from each other on the basis of high and low
cash conversion cycle because of their different profitability ratios.
(QUAYYUM, 2011) have worked on the topic Effects of Working Capital Management and
Liquidity: Evidence from the Cement Industry of Bangladesh they collected the data for 2005 to
2009 from the Dhaka Stock Exchange. The result of this research shows that there is a relative
higher level of relationship between the profitability ratios and various liquidity ratios and
working capital variables of the firm.
(Chhapra, 2010) worked on textile sector of Pakistan to determine the impact of working capital
management on profitability and he finds out a significant negative relationship between debt
used and profitability of firm

(Malik, 2013) in Pakistan they conducted a study about working capital management and
profitability of a firm they have very strong view that there negative relationship between net
operating profitability and average collection time,

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(DELOOF, 2003) examined that there is inverse relationship between profitability and number of
collection days. He conducted this research in Belgian
(Terrell, 2007) concluded that there is inverse relationship between accounts receivables and
profitability
(Uyar, 2009) studied the relationship between c ash conversion cycle and

firm size. And he

concluded that there is a strong inverse relationship between cash conversion cycle and the firm
performance.
(Nobanee) examined that there is a strong inverse relationship between the cash conversion cycle
and Return on asset in all the sectors of economy but not in FMCG and in service sector.
(Anser, 2013) find out that there always an inverse relationship between a firm cash conversion
cycle and return on investment of the firm. ( ZUBAIRI ,2010) conducted a research and find a
relationship between cash conversion cycle and firm size .he focus on automobile sector of
Pakistan and predict that larger firms work more efficiently for collecting there receivables.
(Stine, 1993) conducted that there is a strong need in small businesses for managing properly
their cash conversion cycle because in small businesses there is lack of cash. And he found out
that cash conversion cycle increases profitability because there is less need of cash and also no
need of external borrowing.
(NOBANEE, 2006) conducted a study in United States and he find that cash conversion cycle is
related with working capital management. They both work hand by hand in contributing in the
profitability of the firm. (VIJAYAKUMAR, 2011) examined that the relationship between cash
flow and profitability of the firm. And he found that there is strong negative relationship between
both of them.
(Garcia, 2007) concluded that there is a positive relationship between accounts payable payment
cycle and profitability of a firm. The firms that pay their bills after a reasonable delay enjoy more
profitability.
(ELJELLY, 2004) concluded in his research that there is inverse relationship between cash
collection cycle and profit ratio of a firm.
27 | P a g e

(SEN, 2009) he conducted a study on 220 public limited firms and calculated that there is a
negative relationship between longer cash conversion cycle and profitability. Longer CCC will
lower the profits of a firm.
(HIJAZI, 2006) they conducted a research study on listed companies in Karachi stock exchange
of Pakistan and conclude that there is inverse relationship between arrears inventory and profits
of a firm.
(Sana, 2006) examined a study in oil and gas sector of Pakistan and resulted that there is a very
strong inverse relationship between profitability and cash conversion cycle of a firm, And also
examined that there is also a link between working capital and profitability of firms working in
Pakistan.
(VISSCHER, 1998) done a research work on ten different sectors for the period of ten years. And
find that small firms require a shorter cash conversion cycle as compared to larger firms. And in
response the profitability of small firms increases.
Filbeck and Krueger (2005) give focus on the performance of working capital management and
worked on 32 industries in USA and find that there is variations in working capital tools from
time to time.
Pandey and Parera (1997) provides a base on working capital management policies, they gather
data from different manufacturing firms listed in Sri Lankan Stock exchange. They use
questionnaire as their data gathering tool, and find that there is a unofficial link between working
capital management policy and the size of a firm. And also finds that the profitability of a firm
also great impact on the working capital management policies. They worked on the official data
of Colombo stock exchange. Weinraub and Visscher worked on aggressive working capital
management and finds out a relationship between risk and working capital policies and suggest
that aggressive working capital management policies has higher number of risk and also higher
volume of payoff and conservative working capital management policies has lower risk, and
lower risk lead towards lower returns.
Gardner et al. 1986, Weinraub and Visscher (1998) there is much importance of Working capital
management in firms operations because it has a direct relationship with the financial
performance of a firm.
28 | P a g e

(Smith, 1980) Suggested that in order to lower the risk the firm will have to invest in their
current assets heavily but due to lower risk the returns will fall down. (SOENEN, 1993) worked
on working capital management and profitability of US firms and by using chi-square test and
concluded that that there is strong inverse relationship between net cash conversion cycle and
return on assets.
(Jose, 1996) worked on the working capital management and profitability and collected the data
of US firms and find that aggressive working capital management will tends towards shorter cash
conversion cycle. And by his findings there is a perfect negative relationship between
profitability and cash conversion cycle of US firms. Shin and Soenen (1998) suggested that to
get higher returns we have to invest fewer amounts in current assets; the purpose is to reap the
higher risk which will lead towards higher profits.
(AlHajja, 2009) finds that the firm can increase their profitability by reducing the conversion
cycle and cash conversion cycle is reduced by increasing the payment period to creditors and
increasing the time of payment to debtors and inventory days period cycle, the receivable
collection period and the inventory conversion period.
In contradiction with other studies (Lyroudi, 2000) finds out that there is a direct relationship
between profitability of a firm and cash conversion cycle. and profitability is calculated by
Return on assets (ROA) and net profit margin (Smith, et.al, 1997) used Chi-square test for
analyzing the relationship between CCC and profitability and also finds out that there is a strong
positive relationship between both of them and profitability is calculated by Return on
investment (ROI)
Malitz and Ravid (1993) used open credit terms increases the sale volume of the firm but it
effects the short term financial operations of a firm but narrow credit terms will reduce the sale
volume of firm which lead towards lower profitability. Siddiquee and Khan (2009), concluded
that the effective capital management policies may become firms competitive edge. And the firm
will not need to get loan from outside sources. And find that there is a positive relationship
between working capital management and performance of firm in term of profitability.
Richards & Laughlin (1980) gives the thought of cash conversion cycle in important for
calculating the effectiveness of liquidity management of a firm.

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Lyroudi & Lazaridis (2000) gives the idea that there is greater impact of working capital
management and profitability and also concluded that cash conversion cycle directly affect the
liquidity position of a firm.
Filbeck & Krueger (2003) said that there are many other factors that affects the working capital
management for example interest rate, and increase in interest rate will also show increase in
cash conversion cycle

Chapter#3:
Research Design and Methodology
3.1. Population
Our population is Food Sector of Pakistan.

3.2. Research Approach/Design

Our research is quantitative in nature as we quantify our variables with the help of different
questions. We use different dimensions of each variable, and then use different questions for each
dimension. There is accurate evidence of reliability and validity about the scales is available that
we used in our research.

3.3. Data Collection

Our population is Karachi stock for the year 2006 to 2011.
The data which is used in this article is obtained from financial statements of companies
registered in Karachi stock for the year 2006 to 2011. The sample consists of 54 firms in food
sector.

3.4. Analysis
We use Regression analysis for analyzing the results of our model.

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3.5. Regression analysis

Is a statistical tool for finding the relationship between independent and dependant variable
.There are many techniques in regression analysis by which we can check the relationship
between variables. Regression analysis shows us that how much change accrued in dependant
variable due to change in independent variable while other variables remain constant.

3.6. Cash Conversion Cycle Operationalization

Average receivables period
Average receivables period provides information about liquidity of business; it also helps
managers to develop their companys credit policy which is beneficial for company as well as for
the customers. The time taken by firms to collect its accounts receivables from its debtors or
customers is known as account receivable period. Following is the formula. The outcome of
seasonal sales will be affected by this formula.

Where:
Days = Total no of days in year
AR = Average amount of debtors
Credit Sales = Total credit sales throughout the year
It is important for a firm to analyze the average receivable period , in how many days the
company will collect its receivables to meet its long and short terms obligations.

Average payment period

Time required by a firm to pay its debts to the companys creditors is known as Average payment
period. We can calculate the average payment period by It is a time between the purchase of
goods and its payment (Arnold, 2008, p.531).

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We can calculate the average payment period by

(Average Account payable / Net Credit Purchase)*365

If the payment period of company is lengthy then the firm cannot take the advantage of trade
discounts and other benefits. Companies always try to shorten their payment period for getting
these benefits.APP helps firm to get a better judgment of the cash outflows for future planning.
Judgment of cash outflows has significant role in successful business Average payment period
determines past trends in the payment of the trade credit. Average payment period

brings

managements awareness to variables that must be explore to ensure that the business operations
are working successfully

Days Sales of Inventory

A performance measurement tool which tells us about the in how many days the firm will able to
convert its inventory (including raw material inventory, work in process & finished goods) into
sales. Normally less days in sales inventory is good for company.
It is also an important tool to measure cash conversion cycle. Following is the formula of
inventory in days period.

Inventory days = 365*(average inventory/cost of goods sales)

If a firm is unable to convert its inventory into sales quickly then its a danger sign for firms
growth and it may create problems for firms survival.

3.7. Profitability Operationalization

Net Profit Margin

This ratio tells us how much rupee of profit is being generated by one rupee sales Net profit
margin is commonly represented as a percentage. (Abdul Raheman, 2007) finds that the

relationship between Net profit margin and CCC and concluded that there is a strong inverse
relationship between both of them. Net profit margin is calculated by this formula
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(Net Profit Margin = Net profit /Net sales)

Return on asset
Return on asset is a tool which tells us about how much earnings are generating by company by
usage of its assets. Greater the return on asset the greater will be the profitability.
(Bhutto, 2011) concluded greater the cash conversion cycle of a firm greater will be the total
assets and return on assets. This variable is also used by (SALEEM, 2012), (Afza, 2008),
(Zawaira, 2014) and (Bieniasz, 2011)
The formula of return on asset is as follows.

Return on equity
We can explain return on equity is the amount earned by firm by using shareholder equity. This
ratio is an important tool for evaluating either the firm is working in the favor of shareholders or
not, utilizing their investment effectively we can enhance the firms profitability. Bhutto, 2011)
find that the length of cash conversion cycle has inverse relationship between return on equity
and sales income . To measure the profitability of a firm this variable also used by (M.S Nazir),
and (Zawaira, 2014) . The formula of return on equity is as follows.

Return on Equity = Net Income/Shareholder's Equity

Gross Profit to Total Assets

This ratio tells us how much dollars of GP is earned by each dollar of total assets. With the help
of this ratio we can check that either the firm is using assets effectively for production of gross
profit and net profit or not. To measure the profitability of a firm this variable is not being used
by any other researcher. We calculated the firms profitability by this ratio
The formula of this ratio is as follows

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Gross profit to Total Assets = (Gross profit /Total Assets)

Chapter#4
Analysis
4.1. Regression Equation: 1

In 1st equation Return on assets has been taken as dependent variable, whereas Natural log of
sales, Cash conversion cycle, working capital to total assets and dividend coverage ratio has been
taken as independent variable
Y= +1(NLofS) + 2(Cash cycle) +3(WCtoTA) + 4(dividend CR ) +
= return on assets
1 = Natural log of sales
2 = cash conversion cycle
3 = working capital to total assets
4 =dividend carried ratio
Analysis of variance
R-SQUARE

ADJUSTED R-SQUARE

PROB>F

0.2393

0.2297

0.0000

R-square shows

23.93% of variation in ROA which is explained with the help of four

independent variables .The adjusted R-square is slightly lower than R-square which is 22.97%
F-statistics showing the normal validity of model as its value 25.08 which is significant and the
probability of f is 0.0000
34 | P a g e

ROA

Coef.

Std. Err.

P>|t|

[95%
Conf.

Interval]

NLofSales

.0115076

.0032321

3.66

0.000

.0051487

CCC

.0000428

.0001353

0.32

0.752

-.00002234

.000309

WCtoTA

.00159

.0002851

5.58

0.000

.0010292

.0021508

DividendCR

.0095852

.0028978

3.31

0.001

.0038841

.0152864

_cons

-.1139518

.0449506

-2.54

0.012

-.202389

-.0255147

.0178665

Results:
The above schedule shows the estimated coefficients of the variables.
The Return on assets is positively related to cash conversion cycle, Natural log of sale, working
capital to total assets and dividend coverage ratio .Natural log of sales is positively related with
return on assets and the results are significant with respect to probability of t which is lower than
10 % which shows that our variable is significant. Cash conversion cycle is also directly related
with return on assets but as compare to probability of t the results shows that the variable is
insignificant. While the working capital to total assets also positively co-related with return
assets which means that greater that ratio greater will be the profitability of a firm .Similarly
dividend coverage ratio also positively linked with return on assets. Greater the dividend
coverage ratio greater will be the profitability o a firm
Normally the f value more than 15 in considered as significant and shows good fit of regress
model, here the value of f is 25.08 which is significant .Regress results indicates that slope
coefficient is -.1139518 and Beta coefficient for natural log of sales is .0115076, Beta coefficient
for CCC is .0000428, Beta coefficient for working capital to total assets .00159 and the beta coefficient
for dividend coverage ratio is .0095852. Normally, prob. >T does not exceed 0.10 for statistical

significance of parameter. Therefore, it can be concluded that the variables are significant below
then at 10 percent. P>|t| natural log of sales 0.000, for CCC is 0.752, for Working capital to total
assets is 0.000 and for dividend coverage ratio is 0.001. Normally the t value more than 3 shows
35 | P a g e

that the parameter is significant, here the t value for natural log of sales is 3.66, for CCC .032, for
Working capital to total assets is 5.58 and for dividend coverage ratio is 3.31 which means that
the Natural log of sales, working capital to total assets, and dividend coverage ratio is
statistically significant while the CCC is statistically insignificant

4.2. Regression Equation: 2

Y= +1(GrowtS)+ 2(CCC ) +3(CR) + 4(TATR)
In 2nd equation profit to total assets has been taken as dependent variable, whereas growth
(sales), Cash conversion cycle, current ratio and total assets turnover has been taken as
independent variable

Here is Gross profit to total assets

= Gross profit to total assets
1 = growth (sales)
2 = cash conversion cycle
3 = current ratio
4 = Total assets turnover ratio

R-SQUARE

ADJUSTED R-SQUARE

PROB>F

0.4551

0.4482

0.0000

R-square shows 45.51% of variation in gross profit to total assets which is explained with the
help of four independent variables which means that the dependent variable will change 45.51%
with respect to independent variables .The adjusted R-square is slightly lower than R-square
which is 44.82%

36 | P a g e

GPtoTA

Coef.

Std. Err.

P>|t|

[95%
Conf.

GrowthS

-.0030989

.0044947

-0.69

0.491

CCC

.0003937

.0001351

2.91

0.004

0001278

.0006596

CR

.0030443

.0032717

0.93

0.353

-.0033926

.0094811

TARA

.1746662

.0107789

16.20

0.000

.1534595

.1958729

_cons

-.0519178

.019891

-2.61

0.009

-.0910518

-.0127837

-.0119418

Interval]

.0057441

Results
From the regression results it is concluded that Growth is negatively related with gross profit to
total assets which means that lower the growth (sales) greater the profitability of a firm. But the
cash conversion cycle is positively related with the dependent variable which means that longer
the length of cash conversion cycle greater will be the profitability of a firm. While current ratio
is positively related with the gross profit to total assets which means that greater the investment
in current assets will leads towards higher corporate profits. And Total assets turnover ratio is
also positively related with gross profit to total assets
Normally the f value more than 15 in considered as significant and shows good fit of regress
model, here the value of f is 66.60 which is significant. Normally the t value more than 3 shows
that the parameter is significant, in accordance with our regression analysis results the
parameters growth (Sales) , CCC and Current ratio are insignificant but total assets turnover ratio
is highly significant . Normally, prob. >T does not exceed 0.10 for statistical significance of
parameter. Therefore, it can be concluded that the variables are significant below then at 10
percent. P>|t|. From our results growth (Sales) and current ratio are insignificant but the CCC and
total assets turnover ratio are perfectly significant.

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Table#4

Chapter#5
Limitations, Recommendations & Conclusion
5.1. Recommendation & limitations

For managing working capital effectively there must be a proper match between account
receivables period and accounts payment period.

The main objective of every firm is to increase their profitability, and companies decrease
their cash conversion period by decreasing there receivables period and increasing their
payment period.

We can apply more than one statistical test on this study for increasing
its significance

We can also use cross sectional data and can increase our research
work validity.

We can collect data from more than one stock exchange like Islamabad
and Lahore stock exchange.

In this study we collect date from our country we can increase importance of our study by

collecting data from another country.

The total time available for this research was too short.
This research includes data only from Pakistan food sector; we can take data from other
countries as well.

38 | P a g e

5.2. Conclusion
There is much importance of Cash conversion cycle in every business because it assists
managers for decision making regarding collection of receivables from debtors and payment
to creditors, it provide direction regarding how many days a company should hold its
inventory. The greater the inventory holding period there will be more problems like storage,
damages etc.

Cash conversion cycle is very important for a company to analyze its

efficiency in working capital management.

According to Gardner et al. 1986 there is much importance of Working capital management in
firms operations because it has a direct relationship with the financial performance of a firm.
Companies can increase their profitability by Decreasing the period of cash conversion cycle by
decreasing the accounts receivables collection time period, and increasing the time period of cash
payments or credit payments. The basic objective of every company is to increase the
profitability of the company so the company focuses on all the factors which affect the
profitability of firm. (AlHajja, 2009) concluded that the firm can increase their profitability by
reducing the conversion cycle and cash conversion cycle is reduced by increasing the payment
period to creditors and increasing the time of payment to debtors and inventory days period
cycle, the receivable collection period and the inventory conversion period. There should be
balance between current assets and current liabilities so that the company can work efficiently
with its finances. If the cash will be managed efficiently then there will be less chances of
shortage of cash and insolvency. (Smith, 1980) Suggested that in order to lower the risk the firm
will have to invest in their current assets heavily but due to lower risk the returns will fall down.
(SOENEN, 1993) worked on working capital management and profitability of US firms and by
using chi-square test and concluded that that there is strong inverse relationship between net cash
conversion cycle and return on assets.
In our research we concluded that there is strong positive relationship between cash conversion
cycle and profitability of a firm. In our results Gross profit to total assets and return on assets is
significantly affected by cash conversion cycle. Greater the length of CCC greater will be the
profitability of food sector of Pakistan. our results are in accordance with Katerina Lyroudi they
concluded that The cash conversion cycle is directly related with return on assets and the net
profit margin .
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